ETF Pitfalls

Many investors, traders, and financial institutions utilize ETFs to gain exposure to gold without truly understanding the product they are purchasing. "Exchange traded fund" is not a legally-defined term in securities law statute. Rather it is a market term individually defined by each fund's binding legal documents. ETF structures are quite complex and are designed by the best lawyers money can buy to benefit the share issuers and limit their liability.

In the case of GLD, the largest gold ETF by daily volume, documents such as the Unallocated Bullion Account Agreement, Participant Agreement, and Trust Indenture Agreement severely restrict investor's claims on the trust's underlying assets and limit the Custodian's legal liability. For instance, the GLD Trust Indenture Agreement states that "the Sponsors, Officers, Directors, Employees and Affiliates of the Trust are indemnified against liability for claims in connection with performance, outside of gross negligence, including securities law liabilities". Essentially, if investors sued to recoup losses in the event of the fund's collapse, any judgement would likely be paid out of the fund's assets, if there were any left. Worse still, the GLD Participant Agreement states "the Authorized Participant (investor) acknowledges that it is an unsecured creditor of the Custodian with respect to the gold held in the Participant Unallocated Account and such gold is at risk in the event of the Custodian's insolvency." Therefore, if there is a major financial crisis in which Custodian or Sponsor banks fail, GLD shareholders would be among the last in line to recoup their investment. We believe this would be news to the majority of GLD shareholders. An in depth analysis of these documents can be found at the following link. http://solari.com/articles/Precious_Metals_Puzzle_Palace/

Beyond the hopelessly complex financial arrangements and legal claims surrounding gold ETF investment, there is an inherent conflict of interest for gold ETF Custodians and Sponsors. Current regulations allow major financial institutions and banks to maintain net short positions in gold futures and derivatives markets while serving as gold ETF Custodians and Sponsors. This means they can "sell" derivatives and future contracts based on the current gold price while purchasing bullion on behalf of gold ETF investors. In our opinion, this goes beyond typical market-making activities as physical gold and financial derivatives based on gold price are not the same asset. Some have alleged price-fixing activities result from this unique financial relationship. In addition, ETF share price is determined by supply and demand on the open market, rather than shares being priced on net asset value per share, as is the case with mutual funds. This increases the potential for price manipulation.

Bottomline, if a gold ETF investor believes they own an outright share in physical bullion, they are mistaken. Until recently, gold ETFs were the most convenient option for investors and traders looking to gain exposure to gold prices digitally. However, technological advances now allow for the tokenization of physical assets on the blockchain, a distributed decentralized ledger.

DigixGlobal has leveraged these technological advances to create the DGX token, the first crypto-currency with each token backed by 1g of physical gold. Utilizing ethereum smart contracts, DGX tokens can be exchanged for an equivalent quantity of physical bullion and redeemed by investors. For example, an investor who holds 100 DGX tokens can exchange their tokens for an 'asset card' representing a 100g bar of physical bullion, or visa versa. The asset card stores all of the bar's pertinent attributes on the ethereum blockchain, including quarterly audit sign offs, and can be used to redeem gold directly from the custodian. Clearly this new tokenized gold system is superior to gold ETFs, as each DGX token is specifically backed by physical bullion with no underlying legal agreements or contractual liens. Furthermore, the conflicts of interest discussed above are avoided. Put simply, investment in DGX is clean-cut gold ownership.

Taken with permission from http://www.tflholdings.com/